McDonald’s Headed To $98 Showing Growth Despite The EU Crisis

by Trefis Team
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Europe is the biggest segment for McDonald’s Corporation (NYSE:MCD), with more than 40% of its revenues derived from the region. Due to the European debt woes, the stock has taken a beating with a 15% decline so far in 2012. However, a deeper look at the facts points to a situation which is not as bad as most investors think.

Firstly, due to the franchising nature of the restaurant chain (more than 80% of McDonald’s restaurants worldwide are franchised), the more accurate way of judging a region’s importance is its percentage contribution to operating profits or total franchisee sales. Since the franchisee sales by region are not available for McDonald’s, we consider operating profit. Due to a higher proportion of company-operated restaurants in Europe, the region’s revenue contribution is higher than its operating profit contribution.

Although Europe contributed close to 40% to the total revenues in Q1 2012, it contributed less than 35% to the total operating profits. The U.S. continues to be the highest profit generating region for the company with around 45% contribution to profits.

Since McDonald’s performance in the U.S. has been quite strong, we think the stock deserves a higher valuation than the current market price. [1] For the first five months of 2012, the U.S. comparable sales growth has been an impressive 6.8%. Even Europe, for that matter, has not performed badly given the uncertain macroeconomic environment currently. Year-to-date, the comparable sales have grown 4.2% in the region.

Sure, the comparable sales growth has declined in the past couple of months, but it is only fair that for a fast food chain with more than 33,000 restaurants worldwide, we look at data points over a time scale more than 1 or 2 months. Thus, it is the health of the U.S. economy, rather than Europe’s economy, that is more pivotal for McDonald’s performance. Moreover, the last 3-4 years illustrate that McDonald’s can perform strongly even in a recessionary environment.

Steps Taken by McDonald’s

Of course, consumers don’t automatically flock to McDonald’s outlets. The fast food chain has worked hard to lure new customers and at the same time ensures existing customers keep coming back. Adding items to the menu is one way.

McCafe introduced bubble tea line to its German restaurants on June 11. Choices include black, green and white tea with an option to add syrups of flavors such as lemon, vanilla, peach, passion fruit or mango. In France, two beef sandwiches McFarmer and McTimber were added to the menu in the first quarter of 2012. In general, McDonald’s has promoted less expensive items in France, Italy and Spain, keeping the economic conditions in mind. [2]

McDonald’s is also the official sponsor of the Euro Cup 2012, the popularity of which is huge in Europe. The company has even introduced a tournament inspired Championship Menu which includes Cheese & Bacon Striker and the Chicken Maestro burgers. [3]  The fast food chain is also one of the main sponsors of the Olympic Games to be held in London in the coming month.

Additional steps include refurbishing the existing restaurants to make them appear more upscale. Just as in the U.S., McDonald’s is reimaging its restaurants in Europe. As of Q1 2012, 50% of the interiors and 80% of the exteriors had been refurbished. The company also plans to add 150 McCafes to its existing restaurants by the end of the year. [4]

We have a $98 price estimate for McDonald’s, which is more than 10% higher than the market price.

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Notes:
  1. MCD 10-Q []
  2. McDonald’s May Sales Trail Estimates on Declines in Asia, sfgate.com, June 8, 2012 []
  3. Euro 2012 sponsors ready tactical marketing drives, marketingweek.co.uk, June 7, 2012 []
  4. Q1 2012 earnings transcripts, seekingalpha.com, April 20, 2012 []
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